Zhongdan Investment Credit Guarantee Co. is close to bankruptcy as fears of a wider economic crisis surface.

When investors talk of a Chinese hard-landing they're referring to either four consecutive quarters of below 5 percent GDP growth, or, as China expert Patrick Chovanec points out a financial crisis.

And as loan guarantee company Zhongdan Investment Credit Guarantee Co. that has over 3 billion yuan in loan guarantee contracts stands on the brink of bankruptcy according to Caixin Online, concerns about a financial crisis are beginning to surface too.

First let's understand what Zhongdan does

Zhongdan, as Caixin Online explains pushed borrowers to take out bank loans based on guarantees from the company, and then give a portion of it to Zhongdan for it invest in its own wealth management products. Zhongdan would use those investments to acquire stakes in small companies like pawn shops, which we've previously mentioned are a part of China's shadow banking system, and investment consulting firms.

Since such use of funding "completely violated banking rules" according to Chovanec and to circumvent the issue Zhongdan set up a shell supplier company for instance, got a loan approved by a bank and then de-registered the company.

In January this year, banks began to re-call loans and the companies asked Zhongdan for help and led to a situation in which businesses and banks began to be concerned about credit freeze.

Why this is important

Caixin's sources said they knew this wasn't an isolated incident but there is no consensus on how big this problem really is.

"The concern in China is that — like that tornado — a drop in the local property market, or a decline in exports, could hit all borrowers at once, overwhelming the local credit guarantee company and leaving the banks high and dry. The risk is exacerbated by the fact that many credit guarantee companies were capitalized with loans from the same banks whose other loans they are guaranteeing. In effect, banks are insuring themselves, or each other, and would still end up holding the bag on loan losses that are supposedly insured.

...The Zhongdan episode — which I’m amazed hasn’t attracted more attention and concern — illustrates the kind of hidden risks that have developed in China’s financial system, to which bank and regulators have been willing to turn a blind eye in order to meet the insatiable credit demands of investment-led GDP growth."